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An Optimist Shares His Outlook For Commercial Property in 2024

Dan Vitulli (Photo by Chris Jorda Photography)

As partner-in-charge of accounting and advisory services firm Marcum’s national real estate practice, Dan Vitulli relies on more than two decades of experience in the industry to deliver his clients actionable advice on everything from audits to acquisitions. His diversified practice covers all asset classes including residential, commercial, hotels and industrial properties. No stranger to forecasting, Vitulli counsels clients on what they can anticipate as they wrap up a tough 2023 and look toward what they hope to be brighter horizons.

With one eye on the difficulties introduced and stemming from the pandemic and another on what’s to come, Vitulli’s outlook for the year ahead balances a healthy optimism with the caution and patience of a practically minded realist.

Looking Back: Closing the Book on a Difficult Period
With the poise of an industry veteran, Vitulli lists the industry’s challenges over the past few years: rising rates, falling demand, mortgage obligations coming due and the emergence of a remote workforce.

“In the short term,” he said, “all of these issues will continue to affect the industry, particularly in gateway and tertiary markets, and for property owners with bills coming due.”

Vitulli was relatively early in his career during the Great Recession. He saw first-hand the consequences of that broad economic recalibration, as well as a strong and unexpectedly swift recovery. With that experience in mind, he is among the industry’s senior career professionals who can recognize the unique troubles of an industry in flux without losing sight of the opportunities in a troubled market. From his early instructive experience, he has internalized the importance of facing challenges without getting bogged down by them.

“To serve clients, you need to be able to help them through their immediate concerns and recognize the gravity of the difficult circumstances they may be facing. But it’s just as important, or maybe more so, to keep an eye on the horizon, see what’s coming and help identify opportunities that might be easy to miss,” Vitulli said. “A client mired in challenges can miss the forest for the trees. Offering a counterpoint isn’t just about morale; it’s a great way to deliver value in a challenging environment. Be the extra pair of eyes they need to see what they may not be able to. It’s the same principle in more favorable circumstances. In those cases, you might say be saying the opposite, ‘Plan for the rainy days.’”

What Vitulli sees ahead in 2024 is, if not a complete course correction, at least the prospect of significant positive changes within the industry.

The Long Term: Inflection Point
According to Vitulli, 2024 could prove to be a turning point for commercial office property — particularly for owners and developers with enough accessible capital to build out the amenities renters seek in a more favorable market.

“Renters of office space know the position they’re in. From that perspective, it’s easy to prioritize your business development efforts because we’re back to the first rule in competitive business — offer the best product. In most cases, that means investing in modernization or expanding the amenities available.”

Vitulli’s optimistic outlook centers on the hope that interest rates will stabilize in 2024 and indicators suggesting that hybrid work arrangements are bringing employees and employers alike back into commercial office buildings.

“While we have seen rents coming down in terms of cost per square foot and vacancies increasing, revitalization efforts will enable B & C class buildings to compete for those corporate tenants that are just starting up, relocating, expanding and experiencing growth,” he observed.

Furthermore, “while high employment may have some potential negative implications when it comes to the future of interest rates, I think it’s a promising sign for commercial property. A lot of businesses and executives have had a few years to experiment and now know what they’re missing with a remote workforce,” he noted. “No matter what the future of work looks like, there will be a need for the shared space offices offer. We may not see a return to the standard five-day workweek across the board, but there’s less appetite for fully remote work arrangements.”

Analyzing the Silver Lining
He pointed to one of America’s most resilient post-pandemic markets as indicative of where the global market may be headed.

“In Miami, values aren’t just holding; they are, in some cases, actually rising,” he said. “A lot of companies found it appealing to uproot and move to Miami and South Florida, particularly those in private equity. They’re attracted by the tax laws and the weather. The knock-on effect is that the real estate industry there is insulated from the pain other markets are facing. Not every city can be as appealing as Miami, but Miami is on the crest of a wave that will eventually arrive elsewhere.”

But there can be too much of a good thing.

“Miami itself is losing some of its luster with the influx of arrivals,” Vitulli continued. “Low living costs were part of the initial attraction, but more people have arrived, leading to higher prices on standard ex- penses. That’s caused renters to look outside of Miami, allowing other Florida communities to get some of the benefits that Miami has enjoyed.”

For owners and developers outside of South Florida, he offered tried-and-true advice that has held up over the ages, namely, to tempt renters through revitalization and renovation. But what exactly does revitalization mean to him?

“From my perspective, the term covers everything from improving on-site amenities to a complete re-zoning or rebuild. The modern Class-A building is a marvel that’s hard to replicate without a complete rebuild. Still, renovated Class-B and -C buildings can deliver the advantages that small and medium-sized businesses will find very attractive,” he said. “I worry most for the properties that can’t afford to compete in this way, as well as those that are cautious to a fault. I expect that those who are content to stand still right now will be at the greatest risk of being left behind.”

Companies that don’t have capital to invest can still attract tenants in their own ways.

“The new way of working is all about accommodation and compromise. Developers that can’t invest in large-scale or costly renovations can give tenants what they want in other ways,” Vitulli suggested. “Maybe by being more flexible with their agreements or incorporating shared spaces that tenants can use for events. Being creative and accommodating can help close deals in this super competitive market — and those are major selling points that come at no cost.”

It’s a comforting thought that the old rules still apply. Despite tight lending and less demand, the secret to success remains offering the best option. Is it wishful thinking? Vitulli doesn’t think so. He’s seen the same story play out in another sector, albeit on a smaller scale.

“The parallel I like to draw is to the American mall. For years, it was a cultural touchstone and home to local branches of some of the world’s premier brands. Then things changed with the internet, and it wasn’t long until the mall was declared a product of a bygone era. Between e-commerce platforms, efficient global shipping, and other modern conveniences, the mall was less and less appealing to the retailers that had relied on it for years to reach consumers. The concern was borne out and realized in some ways, but in others, it was massively over-exaggerated,” he said. “These sprawling properties may not be home to the same stores, but they didn’t go anywhere, and they’re still bringing people out in large numbers. They didn’t die out as predicted by so many. They just became something else — and in the new forms they’ve taken, they’re successful.”

Office properties may not ultimately transform into spaces for entertainment centers, multifamily or industrial properties like malls, but Vitulli sees a similar trajectory for distressed office space.

“Retail was in a slump for years just as [other] commercial real estate is now. In periods of distress, firms with foresight acquire properties they feel are undervalued. When things look bleakest for a sector, there are still folks out there with a vision for what is possible,” he said. “Bold strategies don’t always succeed, but in countless cases, companies that take risks on new ideas have been proven right. It just takes ingenuity to see the opportunity and capital to take the project on. I have no doubt that there are many such visionaries with designs on how commercial property will evolve.”

The Short Term: Transition Period
Despite a relatively rosy outlook of what’s ahead, Vitulli is realistic about the short term. More pain is coming over the next several months.

“A lot of the market is underwater, with mortgages coming or past due. There are workouts being hashed out, and lenders and banks reclaiming properties. For example, we are seeing buildings move for deep discounts in San Francisco and Chicago,” he said. “Those that aren’t selling may be the subject of conversations between lenders and borrowers, but certainly there are some positive outcomes there as well. In most cases, I think banks and lenders would much rather figure out workable extension and restruc- turing plans than assume ownership of commercial property, so there’s a lot on the table for those with flexible lenders. With that said, special servicers and real estate attorneys are certainly busy now and will continue to be.”

Like just about everyone, Vitulli is watching the actions of the Federal Reseve closely.

“If they don’t raise rates at the next several opportunities, there will be more comfort that we’ve found a steady state for the market, prices will have reached their natural bottom, and we will see deal activity kick on. We’ve heard a lot about how we’ll land economically, soft, hard or somewhere in between,” he said. “That ongoing conversation shows what predictions can be worth, but we do know that before rates can come down, they’ll need to stop rising. And for the market to feel confident in expansion, we will need to feel that rates are stable and advantageous to investors, so that’s something concrete to look out for.”

Having found so much silver lining, though, does Vitulli lose sleep over a worst-case scenario?

“Certain sectors are strong, particularly the industrial and rental markets, which are doing well. When you consider repurposing, and the success smaller buildings have had transforming into residential conversions, there will be use cases for virtually everything. It might be tougher with larger buildings, but those conversions are underway in places like Chicago, so we will wait and see how they turn out,” he said.

The absolute worst case might be seeing more buildings going through the bankruptcy process, he noted.

“Even in those cases, while devastating for one party, someone is on the other side of the bankruptcy,” he added. “Beyond that, it’s also true that even the most troubled infrastructure asset can have huge value in land costs. That’s one of the great things about the real estate industry: there is fundamental, tangible value almost anywhere you look.”